Herbalife shares down on pyramid scheme allegation

PORTLAND, Ore.
- Herbalife Ltd.'s shares fell sharply for the second day on hedge fund manager William Ackman's allegations that the nutritional supplements company is a pyramid scheme.

The founder and CEO of Pershing Square Capital Management L.P. said Wednesday that he has been shorting the company's stock for several months. Short sellers earn money when a stock declines. Ackman detailed his allegations in a presentation Thursday at the Sohn Conference Foundation meeting in New York and confirmed that he has an "enormous" short position.

According to numerous reports, Ackman claimed in his presentation that Herbalife is misrepresenting some of its financial information to disguise the nature of its business. He alleged that distributors make more money from recruitment than from sales, which he says would define it as a pyramid scheme.

The company's chairman and CEO Michael Johnson said Wednesday that the allegation that Herbalife is a pyramid scheme is "bogus". The company said Thursday that the presentation was a "malicious attack on Herbalife's business model based largely on outdated, distorted and inaccurate information".

"Herbalife is not an illegal pyramid scheme," the company said in a statement.

The company found that a large number of put options on its stock are due to expire Friday and suggested that the timing of the presentation is suspect. A put option is the opportunity to sell a certain number of shares at a certain price and date in exchange for an upfront fee. Ackman denied on CNBC that he has any put options on the stock. He also said he intends to donate his profits from his position on the company to charity.

Herbalife said it asked Ackman to allow Herbalife to participate in his presentation but Ackman declined.

"Now we know why," the company said in a statement Thursday. "Had our executives been there, they would have been able to tear Mr. Ackman's premises and interpretation of our business model apart. His misstatements and mistakes are too numerous to address immediately."

The company, which is incorporated in the Cayman Islands and has its principal operating subsidiary in Los Angeles, sells in 88 countries. It said the U.S. is its largest and fastest-growing market.

Herbalife is urging the Securities and Exchange Commission to investigate the events. It said that this appears to be "yet another attempt to illegally manipulate the market by overzealous short-sellers."

Herbalife's shares fell nearly 10 percent to close at $33.70 Thursday. It was one of the biggest decliners in the New York Stock Exchange for the day. This follows a 12 percent drop Wednesday when news of the short position and other claims were disclosed.

The company still had its proponents in the investment community late Thursday, though.

D.A. Davidson & Co. analyst Tim Ramey said that Ackman appears very confident in his position with a short bet in the $400 million-plus range, a price target of $0 and a thorough and organized presentation Thursday.

However, Ramey disagrees with Ackman's central thesis that Herbalife's compensation in royalties and overrides paid to the top distributors is actually a payment for recruiting. He said the company likely has multiple logical arguments should it ever need to defend itself to regulators.

"We are certain that regulators will review the Pershing Square materials closely but we are highly skeptical that Ackman has exposed anything that is remotely close to a smoking gun," Ramey wrote in a research note.

Ramey also noted that much of Ackman's presentation involved data from many years ago and that the company, which has always been sensitive to criticism, has updated its compensation and policies significantly since 2009.

While Ackman is betting against the company, Ramey said he would gladly take the other side of the bet. He reiterated a "Buy" rating and $72 price target.

This is not the first time that Herbalife's business model has fallen under investor scrutiny.

In May, another noted hedge fund manager, David Einhorn, criticized Herbalife during an investor call, raising concerns that the company's stock may become a target for short-sellers. Einhorn asked how much of the Los Angeles company's products are sold to consumers who aren't distributors, and he asked why Herbalife did not disclose a breakdown of difference types of distributors as it traditionally had.